Accounting concepts and conventions In drawing up accounting statements, whether they are external "financial accounts" or internallyfocused "management

accounts", a clear objective has to be that the accounts fairly reflect the true "substance" of the business and the results of its operation. The theory of accounting has, therefore, developed the concept of a "true and fair view". The true and fair view is applied in ensuring and assessing whether accounts do indeed portray accurately the business' activities. To support the application of the "true and fair view", accounting has adopted certain concepts and conventions which help to ensure that accounting information is presented accurately and consistently. Accounting Conventions The most commonly encountered convention is the "historical cost convention". This requires transactions to be recorded at the price ruling at the time, and for assets to be valued at their original cost. Under the "historical cost convention", therefore, no account is taken of changing prices in the economy. The other conventions you will encounter in a set of accounts can be summarised as follows: Monetary measurement Accountants do not account for items unless they can be quantified in monetary terms. Items that are not accounted for (unless someone is prepared to pay something for them) include things like workforce skill, morale, market leadership, brand recognition, quality of management etc. This convention seeks to ensure that private transactions and matters relating to the owners of a business are segregated from transactions that relate to the business. With this convention, accounts recognise transactions (and any profits arising from them) at the point of sale or transfer of legal ownership - rather than just when cash actually changes hands. For example, a company that makes a sale to a customer can recognise that sale when the transaction is legal - at the point of contract. The actual payment due from the customer may not arise until several weeks (or months) later - if the customer has been granted some credit terms. An important convention. As we can see from the application of accounting standards and accounting policies, the preparation of accounts involves a high degree of judgement. Where decisions are required about the appropriateness of a particular accounting judgement, the "materiality" convention suggests that this should only be an issue if the judgement is "significant" or "material" to a user of the accounts. The concept of "materiality" is an important issue for auditors of financial accounts. Accounting Concepts Four important accounting concepts underpin the preparation of any set of accounts: Going Concern Accountants assume, unless there is evidence to the contrary, that a company is not going broke. This has important implications for the valuation of assets and

Separate Entity

Realisation

Materiality

liabilities. Consistency Transactions and valuation methods are treated the same way from year to year, or period to period. Users of accounts can, therefore, make more meaningful comparisons of financial performance from year to year. Where accounting policies are changed, companies are required to disclose this fact and explain the impact of any change. Profits are not recognised until a sale has been completed. In addition, a cautious view is taken for future problems and costs of the business (the are "provided for" in the accounts" as soon as their is a reasonable chance that such costs will be incurred in the future. Income should be properly "matched" with the expenses of a given accounting period.

Prudence

Matching (or "Accruals")

Re: what are concepts and conventions of accounting Answer # 7 Accounting Concepts The American Institute of Certified Public Accountants defines accounting as the art of recording, classifying and summarising in a significant manner and in terms of money transactions and events, which are, in part at least, of a financial character, and interpreting the results thereof . A business house must necessarily keep a systematic record of its day-to-day transactions to enable stakeholders to get a complete financial picture of the company and to take stock of its financial position on a periodic basis. Stakeholders include the companys promoters, shareholders, creditors, employees, government and the public. The accounting practice is based on certain standard concepts, which enable accountants to convey meaningful information to all stakeholders. These concepts are as follows: The business entity concept According to this, the business is treated as a distinct entity from its owners.

This enables the business to segregate the transactions of the company from the private transactions of the proprietor (s). The money measurement concept Only those transactions, which are expressed in monetary terms are recorded in the books of accounting. Money is the common unit, which enables various items of diverse nature to be summed up together and dealt with. The cost concept The transactions are recorded at the amounts actually involved. For instance, a piece of land may have been purchased at Rs.1,50,000, whereas the company considers it to be worth Rs.3,00,000. The land is recorded in the books of accounts at Rs.1,50,000 only. Thus, an arbitrary valuation of the companys assets is avoided by recording the value at the actual amount involved. Since this amount would have been mutually agreed upon by both the parties involved in the transaction, it is an objective valuation. The going concern concept According to this concept, it is assumed that the business will exist for a long time and transactions are recorded on this basis. This concept forms the basis for the distinction between expenditure that will yield benefit over a long period of time and expenditure whose benefit will be exhausted in the short-term. The dual aspect concept Business firms raise funds in any of the following ways o Additional capital (increase in owners equity)

o Earning revenue (increase in owners equity) o Profits (increase in owners equity) o Additional loans (increases outside liability) o Disposing off assets (reduces assets) An increase in liabilities (including owners equity) and reduction in assets represent sources of funds. These funds can be put to any of the following uses o Purchasing of assets (increase in assets) o Cash balances (increase in assets) o Operational expenses (decrease in owners equity) o Clearing liabilities due (decrease in liabilities) o Losses (decrease in owners equity) All increases in assets and decreases in liabilities (including owners equity) represent the uses of funds. The sum of the sources of funds equals the sum of the uses of funds. Thus, the dual aspect of accounting means that Owners Equity + Outside Liability = Assets This is the fundamental accounting equation. The realisation concept Accounting records transactions from the historical perspective, i.e. it records transactions that have already occurred. It does not attempt to forecast events; this prevents the business from presenting inflated profits based on their expectations. A transaction is recorded only on receipt of cash or a legal obligation to pay. Until then, no income or profit can be said to have arisen. The accounting period concept Business firms prepare their income statements for a particular period. This period, known as the accounting period, is usually the calendar year (January 1 to December 31) or the financial year (April 1 to March 31). Some firms, like trading firms have shorter periods such as a month or less, while others

may have longer terms. The Companies Act, 1956 has set a maximum limit of 15 months for the accounting period. The matching concept According to this concept, expenses borne in the production of goods and services should be matched with revenues realised from the sale of these goods and services. This helps determine the profits or losses for a particular accounting period. The conservatism concept According to this concept, revenues should be recognised only when they are realized, while expenses should be recognized as soon as they are reasonably possible. For instance, suppose a firm sells 100 units of a product on credit for Rs.10,000. Until the payment is received, it will not be recorded in the accounting books. However, if the firm receives information that the customer has lost his assets and is likely to default the payment, the possible loss is immediately provided for in the firms books. The consistency concept Once the firm adopts a particular method for a particular event, it will handle subsequent events of that type the same manner. For instance, suppose it provides for depreciation through the straight-line method, it will follow that method in the subsequent years as well, unless it has sufficient reason to change the method. The materiality concept According to this concept, the firm need not record events, which are insignificant and immaterial. For instance, if a large manufacturing firm has accounts receivables worth crores of rupees, it would not find it necessary to provide for a possible bad debt worth Rs.100.